money managers brace for

Money managers brace for tough Ben
More investors and economists now see the Fed boosting rates further in its rate-hiking campaign.
June 20, 2006: 1:57 PM EDT


NEW YORK (Reuters) - Federal Reserve Chairman Ben Bernanke was careful last week not to utter a word on the direction of interest rates. But that hasn't stopped portfolio managers and economists from ratcheting up expectations for further hikes later this year.

A growing number of investors and economists say they would not be surprised to see the central bank's fed funds rate target - currently at 5 percent - peak around 6 percent.




Not even the harsh stock market sell-off in recent weeks has done much to dent the views of these investors and economists, nor has it produced much change in their appetite for risk.

"I think the sell-off has been a good stress test," said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis. "If anyone had any question about how vulnerable this economic recovery is, its strength has become very apparent."

The Dow Jones industrial average staged a substantial rebound late last week, pushing back toward the 11,000 mark on Tuesday.

Paulsen and others contend that the financial market's downturn, as painful as it appeared, has been a correction of market trends, which clearly had become "unsustainable."

Inflation at 'unwelcome' rate
James Kochan, fixed-income strategist at Wells Fargo Funds Management, and a long-time Fed watcher, said the Fed will continue raising rates, notwithstanding the reverberation from the global market meltdown, because inflationary pressures are building.

The core consumer price index, excluding food and energy costs, rose 0.3 percent in May, the third consecutive monthly increase at that rate. The core CPI increases over the last three months and six months, annualized, have surpassed levels that the Fed's chairman, Bernanke, has declared "unwelcome."

Economists Mickey Levy and Peter Kretzmer of Bank of America in New York have changed their forecast on fed funds in response to inflationary pressures.

At the start of the year, the two economists predicted the fed funds target would plateau at 4.75 percent, but suggested that future monetary policy would be conditional on economic and inflation conditions.

While Levy and Kretzmer forecast a modest slowdown in economic growth, an "upward drift" in core inflation as well as in inflationary expectations will prompt three more rate hikes for a rate target of 5.75 percent by year end, they now say.

The Fed has raised interest rates 16 consecutive times in quarter-percentage-point increments starting in late June 2004, lifting its fed funds rate target to the current 5 percent.

It is widely expected to lift the overnight bank lending rate another quarter point to 5.25 percent at its June 28-29 policy-setting meeting.

Wells Capital's Paulsen said economic growth probably will slow in the second quarter. But he believes it will remain "stronger," more than most anticipate, during the rest of the year.

"The strong comeback in the stock market could add to confidence," he said. "And if the Fed continues raising rates, it could be a sign of how strong policymakers see this global recovery."

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